Tuesday, March 20, 2012

His vehicle - Lightsquared - owned a bunch of satellite spectrum. It was zoned for satellite - allowed to be used for low powered devices that did not interfere with users of adjacent spectrum.

He got its use changed - so that he could use it for high powered devices - that is a terrestrial LTE network. There was a condition. That his devices did not interfere with adjacent devices - namely GPS receivers.

This condition was clear right from the start.

Tests were conducted to see whether Phil's network would interfere with the GPS system.

And it did. And how. The devices could jam GPS at many miles range.

OK - so Phil was not allowed to build his LTE network.

He still owns satellite spectrum. What he started with. The FCC took nothing from him.

But he wants the FCC to give him spectrum he is allowed to use - spectrum more valuable than the stuff he previously owned.

Pretty close to the entire hedge fund community has to take the first choice here. David Einhorn – first choice. Any of the Tiger Cubs. First choice. Even big-name mutual funds are in the first bucket. This was not a survey that was going to be of any relevance to me.

Question 6 revealed the bulk of the rest of the study:

6. In your opinion, which of the following is the most important factor driving decisions among institutional investors in today’s environment? Select one.

Kind of amazing. Performance is not listed as even a possible important factor driving decisions among institutional investors. Let me be blunt: the only things Bronte (or any decent small fund manager) sells are “risk management” and “performance” in that order. Not risk aversion. Fund managers are paid to take sensible risks – and to manage money. If risk aversion is your thing I can produce you a fund with a Sharpe Ratio over 5. I will just invest the money in 28 day Treasury paper. I put risk management first because it doesn't matter how good your performance is if you take stupid risks one day you will get lanced.

The growth aspirations of large fund managers clearly follow their performance:

8. What are your organisation’s expectations for increasing assets under management over the next 24 months?

0%
1% - 3%
4% - 7%
More than 8%
Don’t know

Where are the 50-100 percent growth option that a small successful hedge fund manager might have. These guys live in a world where 8 percent growth over two years is a lot to hope for. A small fund manager hopes to get a multiple of that growth in assets under management just from performance. It is not guaranteed by any stretch. However large asset managers are living in a world of very low expectations.

Half a dozen of the next questions were about regulatory environments and the effects they will have on the business. These were interposed with questions about computer systems (clearly necessary to meet the regulatory issues). However this question gave the game away:

15. What are the greatest data management challenges to the asset management industry today? Select all that apply.

Achieving sufficient scale with in-house systems
Providing a high level of detailed and quality data to clients
Safeguarding investor data
Providing accurate data to regulators and auditors in a timely fashion
Don’t know

Collecting and managing the data on the range of investment choices was not even a concern. Nor was any data necessary to assess risks. Bizarre.

At least on the next question you got to write in the issue that really matters:

16. Which of the following will contribute to your organisation’s ability to expand globally over the next 12 to 24 months? Select the top two.

The strength of our infrastructure
Relationships with key market participants
Brand recognition
Competitive advantage in niche markets
Other, please specify
We currently have no plans to expand globally

What will enable Bronte to expand globally over the next 12-24 months? What about any small asset manager? One word answer: performance. Fund managers - especially small ones - live or die by it. Our most sophisticated customers when they ask us questions ask us almost exclusively about risk management - so if we want to grow amongst those people we need to have a demonstrated culture of risk control and good performance. But still the thing that makes an asset manager grow is performance - if only because 20 percent returns increase your funds under management by 20 percent even if you have no net flows.

Sometimes, looking at some stock in some company I think is fraudulent or insolvent I wonder what goes through the minds of the large institutional shareholders.

But maybe I am just attributing to them motives that they don't have. Maybe I just assume they want to actually manage money (rather than manage regulators and sell product).

Just maybe. Alternatively State Street (who commissioned this survey and whose business is back-office and custody) have no idea of the concerns of their clients.

Monday, March 12, 2012

I wrote a post yesterday which impinges on American politics. I simply observed that the alleged New York Madam who is being locked in solitary for failure to find $2 million in bail money was being denied her constitutional rights.

(I also criticized the recent executive grab for power by Eric Holder.)

I said I thought that the State abrogating Constitutional Rights was an unfortunate trend.

What pleases me is that (with the exception of a second amendment fundamentalist who objected to my off-hand assertion that the provision was antique) I have had almost universal agreement with this observation from both the left and the right.

I have gun-toting law-and-order right wing readers. They agree.

I have liberal readers. They agree.

I have libertarian readers. They agree.

I haven't seen this much agreement in any US political matter for a long time.

That is hopeful.

John

PS. As far as I know I don't have many Christian-fundamentalists who want a Christian State type readers. As I was standing up for the constitutional rights of a woman who is alleged to have provided women for prostitution I suspect there is a fracture line there. I did not see that in comments or emails received.

Sunday, March 11, 2012

I am a resident of a country without a bill-of-rights in our constitution. Whilst I think some of the rights are antique (second amendment, implied right to privacy in the fourth amendment which looks very difficult in the era of "digital papers") it is - I think - an improvement on our system.

That said, it is only an improvement on our situation if the constitution is not ignored.

This week we have seen an amazing power grab by the US Attorney General. To quote Eric Holder:

“Due process and judicial process are not one and the same, particularly when it comes to national security. The Constitution guarantees due process, not judicial process.”

Here is what the constitution says (Fifth Amendment):

No person shall be held to answer for a capital, or otherwise infamous crime, unless on a presentment or indictment of a Grand Jury, except in cases arising in the land or naval forces, or in the Militia, when in actual service in time of War or public danger; nor shall any person be subject for the same offense to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.

I have - for the benefit of the Attorney General - highlighted the relevant section.

Incidentally I have quite a deal of sympathy for extra-judicial execution of a dangerous criminal. "Wanted, dead or alive" posters have been part of the American mythology for a reason. But I gather there was a valid arrest warrant for the person and if the person surrendered there was a legal process. These are I presume "processes of law" rather than (say) a process of the executive. The executive claiming that their process is sufficient to execute someone is - politely - novel.

But it is not the big cases that worry me about America. Its the little cases because through the little cases you can see the erosion of the liberties that made America great affecting ordinary citizens.

Linked is the New York Post article about Anna Gristina - the alleged New York madam with a roster of high class clients. Sure I was reading it for salacious details of who the clients might be. However I found myself getting more annoyed at the process.

You see she is innocent until proven guilty - and she is being locked up in solitary confinement on Rikers Island. Seems rough. But it was the statement that she was being held in lieu of $2 million bond that got me. She is a mother of four with deep connections to the United States. It is going to be hard to argue she is a major flight risk.

But somehow a $2 million bond (way more than most people could post) has been asked. This leads me to the eighth amendment:

Somehow we have come to the conclusion that $2 million is not excessive bail. That I am puzzled by. When did America come to the conclusion that unless you were very rich you should be locked up pending trial for victimless crimes? What is it about the new American culture that does not think that $2 million bail is excessive?

Does anybody care or is Anna Gristina just another person arrested by police and hence guilty until proven innocent?

John

PS. If I had to guess the bail for a similar case in Australia - it would be bailed on her own surety (that is zero dollars). Australia's lack of a bill of rights looks pretty good here.

But they did not get to test those sands (yet) and tool failure meant they could not test the well at its target depth (and they had to plug the lower part of the well).

The question arises though - why didn't they fix the well? Why didn't they do what "big oil" does when it has problems (that is throw money at them). The answer is that they do not have much cash.

The 10K just came out. The first thing I looked at was cash balances. Unescrowed cash was 9.9 million compared to 26.6 million a year ago. At the end of September cash was 15.1 million. Most of the well expense has probably been incurred after year end and the cash balance is almost certainly low single digit million.

Which is not what you want when your tool breaks and it is going to cost a lot of money to fix it. Or even a fair whack of money to test the "net resistive sands".

Still the company is straight about it. The auditor did not give them a "going concern statement" which surprised me. But the company disclosed the problems anyway. Here is the disclosure from the 10K.

While our development costs were funded during 2011 with funds on hand and cash flow from our other producing properties, our funds on hand at December 31, 2011 and anticipated cash flow from operations in 2012 are not sufficient to fund our 2012 drilling budget. Accordingly, unless we are able to secure additional financing or substantially increase our operating cash flow, we may be required to curtail our drilling plans. We do not presently have any commitments to provide additional financing to support our 2012 drilling budget. If we are unable to secure additional financing, we may be unable to meet certain contractual commitments regarding the development of our properties and, as a result, may incur penalties or risk losing some or all of our interest in properties for which we fail to satisfy our funding commitments.

Bluntly if this company does not raise money it will not be able to meet its drilling commitments and may lose all of their interest in all their main properties.

Funny how they did not mention that when they talked about their "net resistive sands".

Lesson: if your tool fails, your stock droops and you have no cash you can lose all your properties. Even if you show some resistance.

Wednesday, March 7, 2012

My blog post suggesting that small-cap stocks were mostly to be avoided roused the animosity of many readers. The problem was that many of my readers see themselves as value investors. A surprising number run small funds and my post was an attack on their world view.

Their logic is that it is impossible for a small fund manager to add value by analysing Hewlett Packard*, Vodafone*, Google* or Total* but by being small and diligent and nimble they can add value by picking small caps. They tell themselves (and possibly their clients) this story every day - it brings meaning to their life. They can add value. By saying just avoid small caps I was asserting that their rationalizations were bullsh-t. No wonder they bristled.

My restrictions were somewhat limited - I was only wanting to avoid buying small caps where the possibility of a go-private transaction was underpinning the price. In other words small caps in safe jurisdictions with good balance sheets and open registers were mostly to be avoided. Private equity mostly can not or will not buy financial institutions (with rare exceptions such as JCFlowers) - and there is some value in smaller financials. Likewise some companies that are already so levered that a debt-financed private equity bid is impossible are potentially interesting. Some German two-class-of-shares mid-caps are also interesting. But even these are at best partial exceptions to my rule of small caps being relatively expensive.

Still the rationalizations of the small cap value managers reminded of Woody Allen's zinger about rationalizations being more important than sex. "When was the last time you went 24 hours without a rationalization?"

One of my readers points out just how cheap it looks relative to potential. He figures the pain (and there has been considerable pain) is more or less over and the stock should race. Without a lot of work I can't even express an opinion on that.

But I will note that the first question when analysing a business is "what will they look like in three, five, ten years". Warren Buffett tells us that when he buys businesses he likes to look out decades. I am a little more flighty than that (and I can always dump the stock) so I tend to look 3-5 years out. Call it the "Wayne Gretzky school of value investing" - look at where the puck is going to be and ask if it is cheap against that.

And when you look out three to five years the biggest determinant of how they will look is what the competition will do to them.

Whatever: on this metric SuperValu is difficult. The grocery market is not growing much in aggregate in the US except through food inflation. And the competition at the bottom end is fierce. I would rather wrestle grizzly bears than compete head-to-head with Walmart. And at the top end the competition is also evil. (The Wholefoods store in Chicago where I irregularly shop is very nice. Certainly nicer than the average Albertsons.)

Sales are going backwards. That does not look like it is going to change - although plausibly the rate of decline may drop. This unquestionably a difficult story where a strained company is fighting with superior competitors. When small caps are cheap (and they do get there fairly regularly) there is no need to take on difficult stories. When to find value you need to go headlong into difficult stories then you are probably deluding yourself about there being value there in any general sense (although there may be value in specific instances).

The focus on SuperValu (a truly difficult story) was confirmatory of my view that on-average small caps are particularly difficult at the moment. [I should note however that SuperValu is something that would not appeal to most debt-funded private equity shops. The company is shockingly levered - and my general restriction against small-caps does not apply here.]

Metrics

I have a few metrics I think about with grocers. The main one is EV (meaning market cap plus debt) to sales. My rough rule of thumb is that an EV to sales of under 0.25 is outright cheap (and only seen either when the whole market is distressed or an individual company is distressed). You have to have a very high quality company to want to pay more than 0.5 times sales. These numbers have to be adjusted for retailers that own much of their property (Walmart, Tesco).

The logic is as follows: grocery retailing is a 5 percent margin business give or take a bit. $100 of sales at an EV to sales of 0.5 is $50 of EV. That $50 of EV would have $5 of operating profit associated with it (5 percent margin on $100 of sales). Now imagine the company had no debt and thus no interest bill. Take out tax at 30 percent and you have $3.50 in after tax earnings. That is for $50 of EV (which in this case is $50 in market cap). The price earnings ratio would be just over 16.6.

To pay more than 0.5 times sales you have to argue that unlevered this company is worth more than 17 times earnings. That is possible if there is a lot of growth potential or the margins are sustainably fat. But 0.5 times sales is a price above which I need to be finding rationalizations to maintain my interest.

When non-distressed grocers with solid market positions trade at 0.25 percent of sales (which is very rarely) they are half that price which is cheap by most measures.

The last SuperValu balance sheet had $396 million of short term maturities and $6.2 billion in long term debt. There is a couple of hundred million in cash - which is such a minimal number I am going to ignore it. (There is 200 thousand dollars cash per store - a number that looks small relative to obvious cash needs including just balances in the till.)

$6.5 billion in debt give or take a little. The market cap is 1.35 billion according to Yahoo! EV is thus 7.8 billion. Last year sales were something like 37 billion (and on a very steep decline of about 10 percent per annum). This year they will be something like 35 billion. EV to sales is just over 0.2 - and will be probably close 0.25 when (and if) they can stabilize sales. This is the bottom end of my EV to sales range but is not an outright distress type figure. Given most this EV is debt I would not be much interested in the debt at par (even though it yields 8 percent). That seems like not much upside and in distress this retailer is going to be worth less than 0.25 times sales.

If perchance the debt were to trade at 70c - implying an EV to sales in the mid-teens - then I might get interested in the debt.

The equity is another issue - one I address below.

My second metric for retailers is how much of a lean they are taking on suppliers. Grocers sell stuff fast - many sell their stuff faster than they pay the suppliers meaning they get free funding from them. If they get into trouble (or they want the cheap finance) they let their supplier obligations blow out. I wrote a post once about an Australian wholesaler (Davids Holdings) which let its supplier obligations blow out and nearly went bust. Not nice.

A rough rule of thumb is as follows. Most suppliers give you 30 day terms. If your payables are more than 30 days of sales you are taking a lean on your suppliers. If you take too big a lean they start getting stroppy and ask for cash-on-delivery or letters of credit or the like. Too much of a lean is pretty tightly defined: most grocers have payables of about 35 days of sales.

In the above table payables are 2.7 billion. That is less than a month of sales - SuperValu is clean on this measure. However note that the accounts payable have gone up as sales have gone down. Whilst the level is not a sign of distress the direction is not good (the reduction of debt is not as impressive as it looks).

Finally - and this is the measure that most bugs me - inventory turn is falling. Inventory is up year on year. Sales are down. For a grocer this is unremittingly bad news. Not only are they using capital less efficiently (getting less aggregate margin per square foot for instance) but slowly and surely the store is turning into one of those places you shop only if you like your groceries pre-packaged and just a touch stale.

Whatever - on the numbers as given this is not that cheap relative to EV and the metrics are going the wrong direction.

You could add - and one of my readers did - that the company is underspending on stores. Tired old stores with slow inventory turns and stale product - that is not the way to take on Whole Foods. And unless you are going to shave margins to nothing it is hardly a way to take on Walmart.

If I had to make a bet on this my guess is that it will have to restructure in some form. This might be a sale (for debt reduction) of a large part of the business or it may be Chapter 11. Whatever - this is not easy and not an obvious value stock.

Would I short the stock?

There is a big short interest in the stock. I think the company is probably going to continue to have a rough time. I am a short seller. The obvious question is "would I short the stock?"

Here the answer is surprisingly no. The company in aggregate is not cheap (EV to sales is going to wind up somewhere near 25 percent) but the equity is cheap. Why? Well if things go right (and things always can go right) and the company gets say 100bps more margin - then the stock looks staggeringly cheap.

There are 35 billion in sales. 1 percent margin increase is 350 million per annum. That is very meaningful relative to a market cap of $1.3 billion. Add in a big short interest and the stock could be very strong.

The leverage that makes this whole thing problematic works both ways. If the management can right this ship the stock could be a big winner.

Have the management done a good job

My bullish commentator thinks the management have done a good job. As far as I can tell he is right. They have shrunk the business (a lot), paid off a lot of debt, and it appears been pretty straight-up-and-down about it. I am a little irked by the falling turnover (it will make the product stale) but that might just be the hand they were dealt.

I have not done a lot of work. I have not walked around these stores. I have not done any apple-freshness tests. But on the numbers I see no reason to believe management have not been pretty good.

That is a blessing and a curse. Good management will be necessary to salvage this situation. But if these stores have been well managed then getting a new broom in can't save the situation. You have to play the cards that are dealt.

Summary

If SuperValu is proof that there is value easily detectable in companies under $5 billion in market cap then - frankly - I think I will take my large caps.

I would not be long this without tangible on-the-ground evidence (from surveying up to 30 stores in different locations) that this really has turned around. Because at the moment this does not pass the Wayne Gretsky test of value. In five years it looks really really bad.

And I would not be short it either with that leverage without a decent understanding of their day-to-day liquidity and just how short-dated the situation is.

This one belongs in the too-hard basket. And half a day is wasted looking at another stock that ultimately I don't care about.

John

*For disclosure purposes we were once short Hewlett Packard but have covered, we are long Vodafone and Google - two of our biggest positions, and we were once long Total but have sold.

Monday, March 5, 2012

Wayne Swan the Treasurer of Australia (in UK parlance the Chancellor of the Exchequer, in US parlance the Secretary of the Treasury) has been publicly criticizing the new Australian billionaires and their political influence warning that they are a risk to the Australian ethos of the "fair go".

He is quoted as follows:

"A handful of vested interests that have pocketed a disproportionate share of the nation's economic success now feel they have a right to shape Australia's future to satisfy their own self-interest."

This will be highly familiar to American readers who have got used to living in a world where lots of money gives you better access to speech. I have barely met an American who disagrees with this sentiment but mainly when the said pile of money disagrees with them.

To liberals in America the Koch brothers are evil incarnate.

Several conservatives think the same thing about Warren Buffett when he argues the rich should pay more tax. Governor Christie's comments were just plain angry. George Soros induces apoplexy in some conservatives.

And most Americans think there is something unseemly about K-Street and the influence peddling lobbyists of Capital Hill.

But in Australia it is potentially much more dangerous than in America. Our new-era Australian billionaires - the ones Wayne Swan rails against - are all billionaires from resource extraction. They all get their money by digging up things that potentially belong to all Australians and selling them to foreigners. And they railed against the resource rent tax (a tax whereby the rest of us got paid something for their bounty). As well they might. And they rail against carbon trading schemes.

Indeed American style money politics in Australia is far more insidious than in the US because our billionaires are far less diverse. A diversity in billionaires (and in the way they make their money) gives us a diversity of billionaire opinion. You can get the Koch Brothers and George Soros in one system - and to some extent their opinions (and the money with which they foist them onto the rest of us) offset each other. The balance is preserved.

Here we risk no balance. And so I am writing a post to tell you just how important Frank Lowy has become. Frank is an opinionated billionaire who made his money from property management and shopping centres. He is "Mr Westfield". He is also highly opinionated and funds his own think-tank (the Lowy Institute). I have in the past disagreed with him strongly - but at the moment I am just darn pleased that he is there.

Lowy is fighting with Clive Palmer (a resources billionaire) about of all billionaire disputes - the business of owning football teams. But I hope that is just the start of it. He is our most opinionated non-resource billionaire, one with a global perspective - and suddenly he is part of the future of Australian democracy.

Frank Lowy (despite the high quality think-tank) has never shown the intellectual depth and breadth of vision of George Soros. I am just as familiar with his influence on local councils (getting his projects approved and his competitor projects rejected) than I am with his global vision. But Frank is all we have got. Billionaire visions are pretty thin around here.

I never thought I would say this. Frank Lowy - your country needs you.

John

PS. I am a hedge fund manager. My job is to find rich people, invest their money and make them richer. The rise of an Australian plutocracy is thus in my interests but I would prefer a plurality of plutocrat clients.

HOUSTON, March 1, 2012 /PRNewswire/ -- As reported in Houston American Energy Corp's (NYSE Amex: HUSA) Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 and in Form 8-K on December 19, 2011, drilling operations on the Company's first well on the CPO-4 block in Colombia, the Tamandua #1, with a projected target depth of 16,300 feet, commenced in July 2011 and was subsequently sidetracked to address drilling issues associated with high pressure and inflows of hydrocarbons and fluids into the well bore. As of December 19, 2011, the sidetrack well had been drilled to 13,989 feet and efforts were ongoing to control the well bore while continuing drilling to the target depth.

Subsequently, and as of March 1, 2012, the Tamandua #1 sidetrack well had a 7 inch liner run to 13,913 feet and was drilled to total depth ("TD") at 15,562 feet. Upon drilling the well to TD, the well encountered Paleozoics which was a clear indication that the TD had been reached.

While the well exhibited oil shows while drilling, and other indications of hydrocarbons such as log analysis that indicate possible productive sands, hole conditions have prohibited sufficient testing on the bottom hole sections. There have been many attempts to evaluate the well resulting in tool failures and stuck pipe, and current conditions are such that the operator has made the decision not to try to reenter the bottom hole sections. As a result of these developments, the decision has been made that without the ability to effectively test the lower zones, the most prudent course of action is to plug back the well and to further evaluate the C-7 and C-9 Formations. As previously reported and indicated by the Logging While Drilling data, the well encountered approximately 200 feet of net resistive sands in the C-7 formation and approximately 140 feet of net resistive sands in the C-9 formation (resistive sands do not necessarily mean pay).

Results of the further evaluation of the C-7 and C-9 formations will be announced as soon as they are available. After attempting to complete the well, the rig is expected to be moved to one of two locations that are currently permitted and ready to receive the rig. In addition, the Operator has five additional locations that are in various stages of permitting, location and construction.

“I would like to make it clear to our investors that the Tamandua #1 well is not being abandoned,” John F. Terwilliger, chief executive officer of Houston American, said in an e-mailed statement today.

“Current ongoing operations are to make a completion attempt in the C-9 and C-7 sands,” he said. “As previously reported, the Tamandua #1 well exhibited hydrocarbon shows in the C-7 and C-9 sands, and logged approximately 200 feet of net resistive sands in the C-7 formation and approximately 140 feet of net resistive sands in the C-9 formation. We are eagerly awaiting the results from these completion attempts.”

This corrects a previous article which unambiguously suggested the well was dry.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.